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When Good Customers Are Bad

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Source: HBR.org/ Remko van Hoek and David S. Evans

Companies don’t just sell product; they sell “delivered product.” In virtually every industry, they coddle customers with supply chain services such as next-day delivery, customized handling, and specialized labeling. But few companies track the real costs of the myriad services they offer—and most have no idea how much they’re losing.

Because conventional accounting methods and average-cost assumptions obscure the true effect of these services on the bottom line, sales executives often view them as minor concessions needed to close the deal. As a result, the high-volume customers who receive the lion’s share of these services may be far less profitable than companies think. Even worse, in their zeal to push sales volume, firms may be implicitly driving their sales forces to extend unprofitable services to the entire customer base.

A Supply Chain Executive Board analysis of 750,000 order records from three companies in the consumer products, process, and electronics industries found that firms providing uncontrolled supply chain services sacrifice substantial profits—up to 20%—for just a 3% to 4% improvement in revenue growth. What’s more, our separate analyses of customer and product profitability revealed that 40% of unprofitable orders are placed by the “best” customers, or those who are ranked among the top 20% most profitable. And 55% of the unprofitable orders placed by large customers are for products that are, on average, considered profitable.

A few companies are now using cost-to-serve analytics to address the problem, among them Dow Chemical, Eastman Chemical, and Georgia-Pacific (GP). In mid-2004, for example, GP used total-delivered-cost analysis to improve the performance of a major customer account. By incorporating cost-to-serve data into the calculation of gross margin, GP’s supply chain team determined that the costs to provide this customer with expedited transportation and distribution services were significantly reducing the profitability of the account. In a top-to-top meeting with the customer, GP used the data to expose the root causes of the high costs and poor service, which included last-minute, uncoordinated promotional planning and purchasing across the customer’s major business units and the customer’s unwillingness to share inventory levels and positioning.

According to Marlene Clifton, the senior director of GP’s supply chain, the customer, once confronted with the data, was remarkably willing to collaborate on ways to improve service. The customer agreed to appoint a single contact within its own company to liaise with a dedicated supply chain manager in GP and to improve terms for managing last-minute promotions.

In the firms we’ve worked with, the CEO has been directly involved in applying cost-to-serve analysis to strategy. Delivered-cost analytics can not only reduce costs but also drive revenue, set a company apart from its competitors, and allow a firm to direct the unprofitable behaviours of profitable customers to less agile competitors.

When did you last analyse the “real” cost of your Best customers – the discounts, one-off deliveries, unbilled hours?

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